Our experts choose the best products and services to help make smart decisions with your money (here's how). In some cases, we receive a commission from our partners; however, our opinions are our own. Terms apply to offers listed on this page.
Maskot/Getty Images
- Chapter 11 bankruptcy allows companies to stay in business while reorganizing their debts.
- Open to individuals and companies, Chapter 11 proceedings can take years to complete.
- A successful Chapter 11 bankruptcy can result in a healthier, more profitable company.
Bankruptcy is often conflated with a company closing permanently. While bankruptcy can certainly spell the end for a struggling business, not all bankruptcies result in liquidation. Chapter 11 bankruptcy, sometimes called "reorganization bankruptcy," gives businesses a chance to restructure and return stronger.
What is Chapter 11 bankruptcy?
Chapter 11 is a section of the United States Bankruptcy Code. This type of bankruptcy gives distressed businesses deep in debt an opportunity to reorganize their assets and debts while allowing them to stay open.
"Chapter 11 is used to reorganize capital structures as well as to facilitate operational improvements," says Jonathan Carson, CEO of bankruptcy services firm Stretto. The specifics of how a company reorganizes itself will vary on its specific situation. "Every situation is different, and any business should engage competent and experienced legal counsel as part of making any determination to pursue a Chapter 11 strategy," Carson says.
While no company wants to declare bankruptcy, Carson says that a company can emerge from a successfully executed Chapter 11 bankruptcy stronger, healthier, and more profitable. Chapter 11 has been used by many notable companies to help them get out of debt and restructure their business. Delta Airlines, Marvel, and Toys "R" Us are just a few companies that declared Chapter 11 and emerged profitable.
What types of debts can be renegotiated or discharged under chapter 11?
Many business debts can be renegotiated during a Chapter 11 bankruptcy. Bankruptcy attorney Philip Sasser from the Sasser Law Firm says that "credit cards, unsecured bank loans, breach of contract liability, broken lease liability, repossession or foreclosure deficiency balances, certain tax obligations, and the unsecured portions of formerly secured loans," can normally be renegotiated under a Chapter 11 bankruptcy.
According to Sasser, Chapter 11 does not protect "a debtor's owners or officers who may also be liable for a particular debt, nor does it relieve the debtor of its obligation to pay its ongoing rent, payroll, and other ordinary operating expenses." Sasser adds that "loans secured only by property that was purchased to be the debtor's residence cannot be modified."
What is the impact of declaring Chapter 11 bankruptcy?
When companies declare Chapter 11 bankruptcy, they are afforded three key rights.
Automatic stay: Under the automatic stay, creditors cannot attempt to collect debts from a company filing Chapter 11 bankruptcy until the proceedings are over. Jim Van Horn, bankruptcy attorney at Barnes & Thornburg LLC, says that the automatic stay is a fundamental protection provided to the company, shielding the debtor's bankruptcy estate from creditors. "The debtor is given a breathing spell, and the stay is effective automatically upon filing," he says.
Van Horn says that the prohibition against debt collection is "very broadly applied to proscribe virtually any collection activity against the debtor or the debtor's property" on claims made before the filing of the bankruptcy petition.
Right to sell assets: Secondly, "the debtor also has the right to sell assets free and clear of liens, claims, and encumbrances, subject to court approval," says Van Horn. This means that a company can sell assets already spoken for to pay creditors if they have court approval. However, a company is not obligated to sell these assets.
Executory contract rights: Third, during Chapter 11 bankruptcy, "the debtor has the right to assume, assign, or reject any 'executory' contract and unexpired lease with third parties, subject to court approval," Van Horn says. This means that a company may get out of some contracts and leases due to Chapter 11 without risking being sued for breach of contract.
How does Chapter 11 bankruptcy differ from other forms of bankruptcy?
The three main types of bankruptcies are Chapter 7, 11, and 13.
The key difference between Chapter 11 and Chapter 7 bankruptcy is that Chapter 11 focuses on reorganization while Chapter 7 focuses on liquidation. If a business fails to restructure debts, it will file for Chapter 7 bankruptcy. Meanwhile, the difference between Chapter 11 and Chapter 13 is that companies are not eligible for Chapter 13.
| Chapter 11 bankruptcy | Chapter 7 bankruptcy | Chapter 13 bankruptcy |
|
|
|
When should a company consider Chapter 11 bankruptcy?
While companies can emerge profitable and more successful out of a successful Chapter 11 bankruptcy, this is a complex, lengthy, and expensive process that shouldn't be taken lightly. Filing for bankruptcy costs $1,738, in addition to the hefty legal fees you'll have to pay throughout proceedings, which can take months or even years.
A company may deem Chapter 11 necessary if it has significant debts that it cannot pay off by their due dates and "wants the opportunity to restructure its debts and other finances to reorganize and continue," Van Horn says.
It's also important to note that while filing for Chapter 11 is usually voluntary, that isn't always the case. Sometimes, a group of creditors can file an involuntary bankruptcy petition against a defaulting debtor.
How does a company declare Chapter 11 bankruptcy?
Bankruptcy is a highly litigious process, so Van Horn advises businesses to consult a qualified bankruptcy attorney or other bankruptcy experts before undertaking this step.
To begin the Chapter 11 bankruptcy process, a business files "a legal document called a bankruptcy 'petition' with the appropriate U.S. bankruptcy court, along with some associated supporting schedules and documentation," Van Horn says. This petition comes with a $1,167 filing fee and a $571 administrative fee, which must be paid upfront by companies or in installments by an individual.
"The goal is to file and obtain court approval of a plan that sets forth all of the contractual terms and conditions of the debtor's reorganization," explains Van Horn. Once this plan is filed, debtors are granted an automatic stay and a 120-day window with the exclusive right to submit a reorganization plan. This period can be extended up to 18 months. Once that period expires, creditors have the right to submit their own plans.
The plan must be approved by a committee comprised of the creditors with the largest claims against the debtor. Once this plan is approved, the repayment period can begin. This period can last for several years, depending on the amount of debt the debtor owes.
During a Chapter 11 bankruptcy, "the business typically continues to operate under the control of the existing management, but with oversight by a court-appointed trustee," says Wayne Mortenson, a bankruptcy attorney at Mortenson Law Offices. When this happens, the business is considered a "debtor in possession."
However, sometimes the court will appoint a "Chapter 11 trustee." When this happens, "the debtor's management is replaced by a trustee who runs the business for the duration of Chapter 11 proceedings," says Van Horn.
Once a company fulfills its obligations under its court-approved plan, they no longer owe any debt, and creditors cannot pursue any claims for debts. They have a clean slate on which to build profits.
Chapter 11 bankruptcy frequently asked questions (FAQ)
What are the advantages of declaring Chapter 11 bankruptcy?
The primary advantage of declaring Chapter 11 bankruptcy is that it allows companies to restructure their debts and operations to be profitable while remaining in business. Companies can renegotiate debts for more favorable terms and are protected against debt collectors. Under Chapter 11, creditors may also be able to renegotiate or get out of no longer advantageous leases. They can also sell assets subject to liens "free and clear" of any encumbrances.
What are the disadvantages of declaring Chapter 11 bankruptcy?
The main downside to Chapter 11 bankruptcy is its cost in time and money, leading to potentially years of proceedings and up to $100,000 in legal fees. A company that declares Chapter 11 also loses some independence. Even if a company stays in control of its day-to-day operations, some of its decisions may be subject to court approval.
Can small businesses declare bankruptcy under Chapter 11?
Because Chapter 11 bankruptcy can be a long and expensive process, this route was not feasible for many small businesses until Congress passed Subchapter V of Chapter 11 in 2019. Caron says this created a faster and less expensive way for distressed small businesses to declare Chapter 11 bankruptcy. To qualify, a small business must meet several requirements, including having under $3,024,725 in debt.